Dr.Johnson receives a lump sum payment of $150 per week.Suppose that the first $150 per week of labor income is untaxed but all labor income above $150 is taxed at a rate of 10%.

Question

Quizplus · Accepted Answer

Since the first $150 of weekly income is untaxed, the after-tax income equation can be written as Y = 150 + 0.9(X-150), where Y is after-tax income, X is before-tax income, and 0.9 is the tax rate on income above $150. This equation has a kink at the point where X = $300 because at that point, the tax rate changes from 0% to 10%. This kink will appear in Dr. Johnson's budget line as well, creating two segments with different slopes. Therefore, choice B is correct. Choice A is incorrect because there is no specific point of leisure where a kink appears. Choice C is incorrect because the slope of the budget line changes at the kink point. Choice D is incorrect because there is a kink in the budget line. Choice E is incorrect because the income constraint is not a horizontal straight line.

DrJohnson Receives a Lump Sum Payment of $150 Per Week